The first phase of the Option Symbology Ini-tiative is now in place. Letters that were once used to describe the strike price and expiration date were replaced by numbers on Feb. 12. In May, the second step of the initiative will be implemented, in which “base symbols” will be replaced by the actual stock symbol.

These are significant steps in a process that has morphed over the past 30 years. And perhaps more important than a change in the way we describe an option contract is the process itself — if for no other reason than it provides a glimpse into how regulators, and the systems they use, must adapt to financial markets that are constantly in flux.

Think back some 35 years, when options were first listed using a five-character code. The first three characters described the underlying security, then were followed by the expiration month and strike price. For example, BNSAH was the symbol representing Bank of Nova Scotia January 40 calls.

The fourth character also allowed users to distinguish between call and put options. If it was a call option, the expiration dates were represented by the first 12 letters of the alphabet, while the next 12 letters signified put options. Thus, the symbol for Bank of Nova Scotia January 40 puts would be BNSMH.

The system worked for stock symbols that had no more than three letters. That system could not accommodate options on over-the-counter and Nasdaq stocks that had four letters in their symbol (e.g., Microsoft Corp., MSFT; Intel Corp., INTC; or Google Inc., GOOG).

The solution was to develop root option symbols specifically suited to stocks that had four or more letters in their stock symbols. The idea was to put the letter Q somewhere in the root symbol to distinguish OTC/Nasdaq stocks. Thus, options on Microsoft had a root symbol of MSQ.

The 1990s bull market caused more problems. Many high-flying technology stocks had strike prices more than 100 points apart. Single letters could no longer be used to distinguish the strike price. The letter B represents a strike price of 10, 110, 210, etc., but when you have those variances on a single stock (e.g., for the March 2010 expiration, Google has options with strike prices ranging from 240 to 900), the system breaks down.

To fix this problem, the options industry moved to wrap symbols that kept the letter indicating the strike price, but changed the three letters used in the root symbol. By the end of the 1995-2000 bull market, there were more than 1,200 wrap symbols representing 100-point strike price variances among options and long-term equities anticipations.

LEAPs, which are options that have longer than nine months to expiration, were first listed in 1990. LEAPs had their own unique needs, not the least of which was a wrap symbol that distinguished LEAPs from regular option contracts (e.g., a regular option expiring in March 2010 vs a longer-term option expiring in March 2011). When LEAPs had less than nine months to expiry, the symbol was again altered to reflect what you would expect to see with a normal option contract.

You can see why the system needed a major overhaul — and that’s not even accounting for non-standard strike prices (e.g., 2.5, 7.5, etc.). The movement to options with single-point intervals and issues around stock splits, special dividends, mergers, acquisitions and spinoffs was much needed.

The options industry decided to engage in a major overhaul and looked to the futures market for some guidance. As of mid-February, stock and index options describe strike prices and expiration dates numerically, as is currently the practice with futures options. This move eliminates the need to alter the root symbol.

For the expiration date, the industry will use the full date. That will account for options that do not expire on the Saturday following the third Friday of the expiration month, such as options on the Chicago Board of Exchange’s volatility index. By using a full date that includes year, month and day, you eliminate any reliance on the root symbol.

A simple C or P defines the contract as a put or call, and that follows the expiration date. The strike price follows the put/call designator and allows for at least three digits after the decimal place.

@page_break@Putting it all together, the option symbol could be as long as 24 characters [e.g.: stock symbol (up to six characters) + date written as yyyy-mmdd (eight) + put/call designator (one) + strike price (up to nine) = a total of 24 characters]. Thus, you can then describe an IBM Corp. July 100 call as: IBM20100717C100.00.

The options industry is recommending that the full stock or index symbol — whether three, four or five letters — be used for all options on that particular stock or index. The numeral 1 would be added to the symbol to account for any corporate restructuring. This root symbol model is expected to be completely in place by May 2010.

As stated earlier, most advisors use chains that list all options under a root stock symbol. Still, advisors should be familiar with the changes and, more important, how your firm will report option contracts in the holdings section of client statements. All of us will have to bone up on the new symbol methodology to explain to our clients what exactly they are holding. IE